PZZA - Papa John's Shake Shack downgraded in Wedbush restaurant review

A review of the restaurant space from Wedbush Securities included a downgrade of a number of chains and the removal of a sit-down operator from its Best Idea List.

Equity analyst Nick Setyan noted that share prices for many restaurant stocks have increased into year-end even as 2023 estimates dimmed. He noted that the expectation of peak inflation promoted some optimism that may have dislocated expectations for margins, which may not recover as quickly as previously anticipated.

Papa John’s ( NASDAQ: PZZA ) was downgraded by Setyan as he sees 2023 EPS estimates as “overly optimistic” amid the aforementioned margin concerns. The downgrade takes his team’s rating to Neutral from a prior Outperform, with valuation also playing a part in moving to the sidelines. By contrast, Domino’s Pizza ( DPZ ) was seen as trending at an attractive valuation compared to pizza-focused peers.

Within quick service restaurants, both Wendy’s ( WEN ) and McDonald’s ( MCD ) are expected to perform well into 2023. Both present strong value propositions to consumers and are consistent executors. By contrast, Jack in the Box ( NASDAQ: JACK ) is expected to encounter more trouble sans a CFO as margins contract and integration of the Del Taco brand remains difficult. As such, the California-based chain was downgraded to Neutral from Outperform. For fast casual, Shake Shack’s ( NYSE: SHAK ) slower recovery within urban markets and diminished value proposition for squeezed consumers prompted Setyan to lower his rating on the stock.

Finally, Setyan expects full service restaurants to remain under pressure into the new year. However, Texas Roadhouse ( TXRH ), Chuy’s ( CHUY ), and Darden Restaurants ( DRI ) are seen as potential winners even as the overall industry faces a myriad of headwinds.

“We view TXRH and DRI as well positioned to sustain share gains within full service, and both have reasonable 2023 margin expectations,” Setyan told clients on Wednedsay. “We also view CHUY as well positioned from both a relative value and relative margin standpoint.”

While Dine Brands ( DIN ) is also expected to defend its margins, refinancing risks amid a rising interest rate environment caused Setyan to remove the stock from his “Best Idea” list. Additionally, Buy ratings were removed from Denny’s Corporation ( NASDAQ: DENN ) and The ONE Group Hospitality ( STKS ) in favor of new, Neutral ratings.

“We are incrementally concerned that STKS and DENN have overly optimistic margin expectations to hurdle in 2023,” he explained. “The former may have priced itself, particularly Kona, at a level that puts it at a relative disadvantage in an increasingly value-conscious consumer environment. DENN, in our opinion, will need to shift its focus more towards value in order to shore up transaction declines at the expense of margins.”

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